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Borrowers with poor credit may qualify for a loan more easily through a captive lender.
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Captive lending is a type of in-house financing often found at car dealerships.
This type of lending is convenient and often more flexible than other financing options.
You may pay a higher price or interest rate with captive lenders than with other lenders.
If you’ve ever purchased a car, you may have used captive lending — a type of in-house financing auto dealerships commonly offer.
According to Experian, about 46% of new car purchases this year were financed using this type of financing. Two years ago, it was nearly 60%. Are you considering a captive lender for your next purchase? Here’s what to know about this practice and its pros and cons.
What is captive lending?
Captive lending, sometimes called in-house financing, allows customers to finance a purchase directly through a subsidiary of the lender and spread the cost (plus interest) over time. You’ll typically apply for captive financing on-site at the point of sale.
“If you’re at a dealership ready to buy a car, and the dealer says they can help you pay for that car with an in-house loan, that’s an example of captive financing,” says Howard Dvorkin, an author, certified public accountant (CPA) and chairman of Debt.com.
Consumers will most often encounter captive lenders at dealerships, but retail businesses sometimes offer them as well. Common industries that use captive financing include:
Medical suppliers or providersSecondary education and trade schoolsWholesale clubsBuyers clubsHeavy equipment providersHome improvement companiesMusical instrument retailersMedical spas
A business may offer captive financing for many reasons. It can create an additional income stream, limit its risk, or differentiate itself from competitors.
“They may be looking to create a competitive advantage over other sellers in their industry,” says Shaun Lucas, CEO and president of Monterey Financial Services. “Traditional lending options available to consumers are often limited when it comes to term, interest, early payoff options, and underwriting. Taking the option to finance in-house gives the business more control over the financing terms offered, further helping to simplify a customer’s purchase.”
BenefitsDrawbacks
More flexibility in loan terms
May be easier for low-credit borrowers to qualify
May come with more promotional options
May come with aggressive up-sellingOften coupled with higher interest ratesMay lead to inflated prices
What are the benefits of captive financing?
The biggest benefit of captive financing is greater flexibility to customize terms to the customer’s needs and budget. The business also has more control over the underwriting of the loan, which can help consumers — particularly those with lower credit scores — qualify more easily.
“It can be a good option for a person that is trying to build credit as they may approve someone that a traditional lender may not approve,” says Carlos Legaspy, president and CEO at Insight Securities.
Captive lenders are also convenient and often have unique discounts, rebates, and promotions — like introductory 0% APRs — that aren’t available with more widely used financing options. These perks can save consumers money, both up front and in long-term interest.
You may need to choose between promotions (like a lower interest rate or a cash rebate, for example) when using a captive lender. Additionally, your intro rate may only be valid for a limited time. Read the fine print and know when and how much your interest rate can increase.
Important: While lower-credit borrowers may have an easier time qualifying for captive loans than bank loans, they might not be eligible for dealer perks and rebates. The deals may also only be available on new cars — not used ones.
What are the downsides of captive financing?
According to the Consumer Financial Protection Bureau, in-house financing can sometimes come with inflated prices and higher interest rates when compared with other types of financing.
You also may encounter aggressive up-selling tactics with captive lenders, which could mean buying costly add-ons or upgrades you don’t have the money for or need.
“The main drawback is that interest rates tend to be higher and, for an undisciplined buyer, it may influence them to buy something they can’t afford,” Legaspy says.
Important: Don’t be afraid to negotiate your rate and payment. Captive lenders have a lot of control over their terms, so getting quotes from other lenders and leveraging them could help you get a better deal.
Is a captive lender right for you?
Captive lenders can be smart for some consumers, but they’re not for everyone. The right choice depends on the type of car you’re considering, your budget, credit score, and other factors. Also, not every dealer offers in-house financing, so a captive lender could limit what brand of car you can purchase.
If you’re unsure of the right move, talk to a financial professional or credit counselor who can advise you.